SummaryInformation economics, also known as economics of information, is the study of how different degrees of information affect economic analysis. Since it’s usually studied as a part of microeconomic theory, information economics mainly deal with micro problems. In this Learning Path we learn the basics about information economics, especially about adverse selection and moral hazard.
The agency theory is based in the relationship between principals and agents. In economics, this theory comes as a result of the separation between business ownership and its management.
The internalisation of a firm’s management instead of hiring external agents is a milestone in Oliver Williamson’s transaction costs theory. The agency theory is necessary in order to provide an incentive structure that acts as a catalyser, between the principal’s desire and the agent’s interest.
In the relationship between principal and agent we face the problem of the existence of asymmetric information and risk aversion. The principal will have the tendency to regard the agent’s actions as imperfect, understood as actions not aligned with the principal’s desires. Therefore, he will have to design a contract were that negative effects are minimised. Asymmetric information can come in two possible ways, depending on the information known at the moment of taking the decision. Ex ante is related to adverse selection and ex post to moral hazard. Agency theory helps determine the optimum incentive relationship between principal and agent so that both parties can achieve a maximum satisfaction. This will have to be done via optimum incentive contracts, so that both interests are linked with a positive correlation.
The critiques to this theory arise from the fact that it does not include limited rationality contrary to the transaction cost theory. It is assumed that the principal knows the agent’s utility function and what contract is more adequate for each one. Furthermore, it is also probable that the theory overestates management problems ineficiency due to its static approach.
This theory has important economic significance. Regarding the public sector it helps explain some attitudes to privatise companies, or to outsource services. It also has other connotations for business’ institutional innovation, as for example, in franchisesand its principal-agent relation framework.